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REC: Power sector woes dampen asset quality

Jan 31, 2012

Rural Electrification Corporation (REC) declared its results for the third quarter of the financial year 2011-12 (3QFY12). The institution grew its net interest income by 19% YoY and profits by 16% YoY during the quarter.

Performance summary
  • Income from operations grows 27% YoY in 3QFY12 and by 26% in 9mFY12 on the back of a 25% increase in the loan book.
  • Net interest income however grew at a slower pace on higher interest costs, rising 19% YoY in 3QFY12.
  • Disbursements grow by 11% YoY, sanctions however fall by 7% YoY in 9mFY12.
  • Non-interest income falls by 45% YoY during the quarter, while falling 21% during the first half.
  • NIMs fall to 4.4% at the end of 9mFY12 from 4.6% at the end of 9mFY11 on higher borrowing costs.
  • Bottomline grows by a marginal 16% YoY in 3QFY12 on a forex gain and by a lower 10% in 9mFY12 on account of forex losses; higher interest costs, provisioning, and lower other income.
  • The company declared an interim dividend of Rs 5 per share.

Standalone numbers...
Rs (m) 3QFY11 3QFY12 Change 9mFY11 9mFY12 Change
Income from operations 20,860 26,501 27.0% 59,507 74,775 25.7%
Interest expended 12,380 16,449 32.9% 35,468 46,130 30.1%
Net Interest Income 8,480 10,052 18.5% 24,040 28,645 19.2%
Net interest margin**       4.6% 4.4%  
Other Income 894 490 -45.2% 2,088 1,646 -21.2%
Forex (gain)/loss (26) (866)   (294) 462  
Operating expense 386 779 101.6% 1,114 1,652 48.4%
Provisions and contingencies - 241   1 491  
Profit before tax 9,015 10,389 15.2% 25,307 27,686 9.4%
Tax 2,374 2,693 13.5% 6,610 7,143 8.1%
Effective tax rate 26.3% 25.9%   26.1% 25.8%  
Profit after tax/ (loss) 6,641 7,695 15.9% 18,697 20,543 9.9%
Net profit margin (%) 31.8% 29.0%   31.4% 27.5%  
No. of shares (m)         987  
Book value per share (Rs)*         144.5  
P/BV (x)         1.3  
* (Book value as on 31st December 2011) ** Annualized

What has driven performance in 9mFY12?
  • Despite rising interest rates, and a slowdown in infrastructure activity, especially in the power space, REC saw its loan book grow by 25% YoY in 9mFY12. Sanctions however saw a decline, falling by 7% YoY in 9mFY12. Disbursement growth came in at 11% YoY. Disbursements had a higher leaning towards generation with 49% going to the segment, compared to 51% previously. T&D (Transmission and Distribution) projects got a 38% share (35% previously). 82% of the company's loan book continues to be exposed to state governments. The company has cut its guidance for disbursement growth for the year from 25% to around 16%, however it still expects good growth in the loan book on existing sanctions.

    Fresh sanctions take a hit...
    (Rs m) 9mFY11 9mFY12 Change
    Sanctions 438,610 407,700 -7.0%
    Disbursements 161,990 179,440 10.8%
    D/S ratio 36.9% 44.0%  
    Advances* 757,440 949,580 25.4%
    * excludes interest accrued and due

  • REC has witnessed an improvement in its net interest margin (NIM) in recent years. Besides lower cost of funds the fact that it derives market linked yields for funding transmission and distribution schemes, also provides an upside to its NIM. Further, a rise in interest rates will not hurt REC as the institution's lending rate is not locked at the time of sanctioning the loan. The sanction runs for 3 to 4 years before it gets fully disbursed. Hence there are very few downsides to REC's NIM even in a rising interest rate scenario. Having said that, 13 rate hikes orchestrated by the RBI did lead to some margin erosion, which fell to 4.4% from 4.6% earlier. However this was more due to a reversal of interest income on Konaseema Gas Power Project (now classified as a non-performing asset (NPA)).

  • REC's borrowings from banks stand at only 7% of its overall borrowing portfolio, compared to 17% in 9mFY11. Thus, it may not be as exposed to bank's rising base rates, compared to other NBFCs. It has not opted for bank loans this fiscal on account of the high prevailing interest rates in the country. Is has seen a huge increase in forex loans, preferring to avail of cheaper funds from abroad. The only unhedged portion of its forex borrowings is US$ 250 m, with the rest of the US$ 1.25 bn being fully hedged. It plans to raise additional money though the forex route and has also asked for permission to raise a US$ 1 bn Foreign Currency Convertible Bond (FCCB).

  • It saw some forex gains in 3QFY12 on account of rupee appreciation, however for the 9 month period this account was still in the red. For accounting for foreign currency translation, REC has opted for amortizing the foreign exchange fluctuation over the balance sheet period of these borrowings. This led to the Profit before Tax (PBT) for the nine month period to be higher by Rs 1.9 bn. However going forward this change should lead to less fluctuation on the P&L account and give a more accurate picture of the financials.

    Borrowing Profile
    (Rs m) 9mFY11 % of total 9mFY12 % of total Change
    Capital Gain Bonds 105,410 17% 125,640 16% 19.2%
    Institutional Bonds 369,970 59% 532,990 66% 44.1%
    Banks, FIs, etc. 110,350 17% 55,010 7% -50.1%
    Foreign Currency 44,020 7% 96,890 12% 120.1%
    Commercial Paper 2,500 0% - 0% -100.0%
    Total 632,250 100% 810,530 100% 28.2%
    * FIs = financial institutions

  • REC had 0.52% gross NPA levels at the end of 9mFY12; this is an increase from 0.03% levels seen in 9mFY12. The increase in NPA levels was on account of non-performing assets of Konaseema Gas Power project which has defaulted on payments. Overall a Rs 450 m was taken for the same including reversal of interest income. This project had fuel supply issues as well as problems with tariff increases, and was restructured during 2QFY12. However, it still could not make payments and thus was classified as an NPA. Last quarter also an increase in NPA levels was seen on account of the Maheshwar Hydroelectric project. Unless things get resolved on the fuel supply front and power tariffs are raised to cover increased costs, the sector will continue to see some stress. REC however does not expect a significant decrease in asset quality over the long term as power is a necessity, however in the short term some more stress can be expected.

What to expect?
At the current price of Rs 183, the stock is valued at 1 times our estimated FY14 adjusted book value. As per the management, the company will try and maintain its asset quality as the Ministry of Power is building up pressure on various state governments in order to increase state electricity boards' (SEBs) tariffs. This will help them meet their loan obligations. However fuel supply is another important concern, which will need to be met by either importing coal from overseas or by bringing in private sector coal miners.

Even in a high interest rate environment, REC is well equipped to manage NIMs and spreads, on account of its overseas borrowings through ECBs. It has been able to maintain its spreads at 3.2% even with RBI's excessive rate hikes. Irrespective, it has seen robust loan growth, and this is expected to remain at around 25% for the fiscal. Asset quality has also deteriorated on account of the said problems in the power sector; however on a long term sustainable basis the institution does not see too much stress on this account. We reiterate our 'Buy' view on account of the reasonable valuations the stock is trading at currently as most of the pains have been priced in.

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Jun 14, 2021 (Close)